We’ve written a lot about the CARES Act in recent weeks; the $2-trillion Congressional relief act is packed with provisions that impact savers. Today, we want to touch on an aspect of the law that may be helpful for those whose jobs or businesses have been hurt by the virus—the ability to take early distributions from retirement accounts before reaching age 59½.
Generally, early withdrawals from a retirement account come with a hefty tax bill. In addition to being taxed as part of your income for the year, withdrawals prior to age 59½ are subject to a 10% federal income tax penalty. But the CARES Act has made a few changes to these rules to allow those who’ve been hard-hit by the virus to access their savings.
Eligibility requirements are fairly broad. If you, your spouse or a dependent have been diagnosed with COVID-19, or if you’ve lost work, been unable to work because of a lack of child care, or experienced other adverse financial consequences due to COVID-19, you may be eligible to take a coronavirus-related distribution.
Note that we typically recommend investors seek other options before making an early withdrawal from a retirement savings account. While the CARES Act has made it a little less painful for people who need to do it, we’d suggest consulting with your adviser before taking advantage of this provision.
That said, here’s what you need to know if you’re considering this type of withdrawal:
- The 10% early-withdrawal penalty on distributions from retirement accounts has been eliminated for coronavirus-related distributions
- You can withdraw up to $100,000 from your IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. for coronavirus-related reasons. You may be allowed to take it from your employer’s qualified retirement plan, such as a 401(k) or profit-sharing plan, if the plan allows it
- You can take distributions from several IRAs as long as you do not take out more than $100,000 in total
- You will have the option to pay income tax on the distribution(s) for tax-year 2020 or spread the liabilityLiabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.). out evenly over three years
- If you choose to recontribute some or all of the amount withdrawn within three years (either as a lump sum or over time), you can claim refunds for taxes paid on the amount you reinvest
- In addition, you can recontribute to one or several IRAs, and they don’t have to be the same accounts you took the distributions from originally
- There are no limitations on what you can use the funds for during the three-year period
- Note that this kind of distribution is different than a 401(k) loan—the rules for repaying those loans have not changed, though the CARES Act gives the option of delaying any payments due in 2020 by a year. Otherwise, all of the existing loan conditions (penalties on not repaying, tax treatment and deadlines) still apply
In essence, a coronavirus-related withdrawal could end up working like a tax-free rolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax., albeit one with a number of hoops to jump through. While you have to pay taxes on the withdrawal, you can get them refunded by making an equal-value reinvestment over three years.
Taking early withdrawals from your retirement accounts gives you another option during these uncertain times, but it could come at the cost of missing out on some tax-deferred or tax-free growth. We recommend carefully considering the tradeoffs and your other options before taking this kind of withdrawal. Please give us a call if you have any questions about your situation and how this type of distribution could work for you.
This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.
Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional, or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.
Companies mentioned in this article are not necessarily held in client portfolios and our references to them should not be viewed as a recommendation to buy, sell or hold any of them.
© 2020 Adviser Investments, LLC. All Rights Reserved.